The 50-30-20 budget rule is an easy way to manage your finances by dividing your after-tax income into three primary categories. This budgeting challenge is intended to help consumers manage their money effectively while meeting all their financial needs. Here is how the 50-30-20 budget rule works.
- 50% for Needs. These are essentials you can’t live without—like rent or mortgage, utilities, groceries, insurance, and minimum debt payments.
- 30% for Wants. This portion of your income covers non-essentials that enhance your lifestyle, such as dining out, entertainment, travel, and subscriptions.
- 20% for Savings and debt repayment. This portion is allocated toward building your emergency fund, investing for retirement, or paying off debt beyond the minimum payments.
The 50-30-20 budget rule was made popular by Elizabeth Warren in her book, All Your Worth: The Ultimate Lifetime Money Plan, according to Investopedia. This budgeting rule does not allocate funds to every item in a budget. Instead, it allocates a percentage of after-tax funds into three categories: savings, wants, and needs.
Let’s examine each section of the 50-30-20 budget rule in more detail with examples.
Use 50% of your net income to cover your needs.
The money you spend on your needs plays a vital role in your financial stability. According to the 50-30-20 budget rule, 50% of your income must go to things you need. The question is, what is a need?
A need is something important in your life that you cannot live without. For example, you cannot live without food or a place to stay.
Needs differ from one person to another. However, the following are some of the everyday needs that 50% of your income should cover.
- Rent/mortgage
- Food
- Utilities
- Health insurance
- Transportation
- Etc
For example, let’s assume that your net income is $5,000 every month. The 50-30-20 rule suggests that 50% of this income should be used to cover all your needs. With this rule, you must use $2,500 to cover your needs.
Any allocation exceeding 50% of your needs will violate this rule. No matter how many expenses you have, make sure that all your needs can be covered by 50% of your net income.
Use 30% of your net income toward wants.
Here comes the part that everyone enjoys, but also the part that causes the most financial troubles.
The 50-30-20 rule suggests that 30% of your net income should be spent on your wants. Wants differ from one person to another depending on income and lifestyle.
The following are common wants that you probably share with others.
- Movies
- Eating out in restaurants
- Endless shoppings
- Gifts
- Funding your travels and vacations
- Funding all your hobbies, etc
From our example, 30% of your net income($5,000) will be $1,500. All your wants must be covered by $1,500 or less.
Use 20% of your net income toward savings and paying off debt.
The remaining percentage of your income will go to savings. Savings take many forms, and there are various types of accounts designed for savings.
Most people think that saving money has only three meanings: Putting money under the mattress, in a savings account, or in a piggy bank for later use.
The truth of the matter is that saving takes many forms, and these vary from one person to another. For example, the money you allocate towards retirement is considered savings.
The following are ways you can use that 20% toward your savings and paying off debt.
- Put a portion of your money into retirement accounts
- Pay off your debts
- High-yield savings accounts
- Retirement savings accounts such as 401(k) and IRA
- Investments such as CDs, Mutual Funds, etc
Although the 50-30-20 budget rule sounds simple and straightforward, most people fail to apply it. There is a lot of confusion between what is a need and what is a want. Therefore, people often treat restaurant expenses and shopping as necessities, as emotions drive their money decisions.
By the time they get to actual wants, there is nothing left. What they do is use the little money they have to satisfy their never-ending spending desires.
Not knowing your priorities and spending without budgeting your money is a big mistake that will prevent you from applying the 50-30-20 budget rule.
Is using the 50-30-20 budget rule a good money strategy
The 50-30-20 rule will help you get started with managing your money. However, I think you need to make some adjustments to this rule to increase your savings.
It is essential to recognize that the 50-30-20 rule is effective, and it is reasonable to spend 50% of your net income toward your needs.
However, I don’t think you should spend 30% of your net income on wants, in addition to the 50% you already spend on needs.
This means that your wants and needs are consuming 80% of your net income. Out of the $5,000 we used in our example, only $1,000 will be allocated to your savings. This is not a smart budgeting strategy.
What I think is a much better method is to make the rule a 50-20-30.
This modified budgeting rule can help you save 30% of your net income, leaving you 20% to spend on your wants. You can also take this one step further and use the 40-10-50 approach (40% on needs, 10% on wants, and 50% on savings). I call this method an aggressive savings method, and it works well for people who are nearing retirement.
The idea here is that the 50-30-20 rule can be modified to meet your financial needs. The smartest decision you can make is to reduce your expenses and increase your savings. The more money you save, the faster you will achieve your financial stability.
